The Covid-19 pandemic has focused attention on the opportunities in the global healthcare sector, especially on companies that are applying or adopting new technologies. Concurrently, continued Sino-US tensions, which threaten traditional supply-chains and the dissemination of technological know-how, have accelerated moves towards greater self-sufficiency in China.
“Import substitution is a key trend, as China healthcare companies gain share from multi-national companies by offering better value-performance products,” said Vincent Yu, healthcare & industrials research analyst, Greater China equities, at JP Morgan AM.
“Market consolidation is another characteristic of the sector, as the most resourceful and efficient companies are gaining market leadership in a highly fragmented sector,” he told FSA.
Examples of firms benefitting from import substitution are IVD and medical device companies AutoBio and Kangji Medical, while Laobaixing Pharmacy and Yifeng Pharmacy are winning the race for market share, according to Yu.
The potential in the sector has encouraged asset managers to launch thematic funds focused on Chinese pharmaceuticals, biotechnology and healthcare services. Most recently, Value Partners gained approval from the Securities and Futures Commission last week to sell its Value Partners Health Care Fund to Hong Kong retail investors.
JP Morgan AM manages two Luxembourg-domiciled Ucits available to Hong Kong and Singapore retail investors which have out-sized bets to China healthcare stocks.
The $3bn JP Morgan China Fund, run by Howard Wang and Rebecca Jian, had an 11.3% exposure to China healthcare stocks (including a 3.1% allocation to Wuxi Biologics) as of the end of September, compared with a 6.4% weighting to the sector in its benchmark MSCI China 10/40 index, according to its factsheet.
It has achieved a three-year cumulative return of 70.42%, significantly outperforming its benchmark (22.78%) and the 22.1% average return for China funds, according to FE Fundinfo.
The fund’s NAV fluctuates more than its benchmark, with 24.4% annualised volatility over the same period versus 22.2% for the index, but it has Sharpe ratio — a measure of risk-adjusted returns — of 0.63, which is much better than its peers (0.18), FE Fundinfo data shows.
Wang and Jian also run the $254m JP Morgan China A-Share Opportunities Fund, has 18.3% invested in China healthcare stocks, almost 11 percentage points more than its CSI 300 index benchmark, according to Morningstar research (30 September).
Top holdings including Jiangsu Hengrui Medicine, which JP Morgan’s Yu highlights for its “fast adoption of innovative drugs”, and which Morningstar senior analyst Claire Liang describes as one of the fund’s “solid stock picks” in the healthcare and technology sectors that have “added the most value” to the fund’s performance.
The fund has generated a 57.6% three-year cumulative return in US dollar terms, more than double the 24.6% return by the CSI 300 index. It is more volatile than its benchmark and peers, with 24.7% annualised volatility over the past three years, compared with 22.6% and 20.4% for the index and sector respectively, FE Fundinfo data shows, although a superior Sharpe ratio of 0.52 indicates that taking higher risk bets has been justified.
Growth versus value
There has been a divergence in valuations (as measured by price-earnings ratios — PERs) within the China healthcare sector, as companies with stronger innovative capability, more comprehensive product portfolios and brighter growth outlooks are trading at forward PERs of 20-25 times, according to Yu.
On the other hand, companies that face higher policy risk with weaker product pipelines have had their PERs de-rated to mid-to-low teens, which is in line with the valuation divergence between growth and value stocks in other sectors.
“It is a positive development that investors have become more willing to assign value to companies which might be unprofitable now but have the potential to bring novel products to the market in the future to fulfill unmet medical needs,” said Yu.
Companies whose products are meeting evolving medical needs include Amoy Diagnostics, leading drug innovators include Innovent and Hengrui, and Wuxi Biologics and Tigermed are capitalising on significant investment in R&D by providing services in demand, according to Yu.
The introduction of new listing rules (for example, Chapter 18A for the Hong Kong market and Sci-tech Board in mainland China) have given many early-stage enterprises access to capital which can be invested new technology and products to strengthen their market position.
“It could also create a positive cluster effect that will speed up the industry development in China and encourage more companies to shift their resources to high value-added R&D,” said Yu.
JPM China Fund and JPM China A-Share Opportunities Fund vs sector average and benchmarks